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Andrew F.

Haughwout and Ebiere Okah

Below the Line: Estimates
of Negative Equity
among Nonprime
Mortgage Borrowers
• Evidence from the current downturn suggests 1. Introduction
that declines in borrower equity are fundamental
contributors to the rise in delinquencies and
defaults on nonprime mortgage loans. T he boom in nonprime mortgage lending that occurred in
the United States between 2004 and 2006 was quickly
followed by rapid increases in the rate of delinquencies and
• Measures of housing units with negative foreclosures on these loans.1 This pronounced deterioration
alarmed investors, the public, and policymakers.2 Significantly,
equity—in which the mortgage balance
uncertainty about the source of the decline in loan quality has
exceeds the value of the collateral property—
played a key role in the credit crunch that began in mid-2007.
have become a key component in crafting
Nonprime loan originations rose sharply after 2003 (Chart 1),
policies to address the foreclosure crisis.
and these loans became delinquent far more quickly than had
earlier vintages. Indeed, loans originated in 2004 performed
• An analysis of the prevalence and magnitude poorly compared with earlier vintages, and the 2005 and
of negative equity in the U.S. nonprime 2006 vintages became seriously delinquent within a year of
mortgage market finds that negative equity origination at rates that the 2003 vintage took twenty and thirty
is closely associated with the time and place months to reach, respectively.3
of mortgage origination and with the existence
of subordinate liens against the property. 1
In this article, the nonprime market consists of subprime and alt-A loans.
Compared with prime mortgage loans, subprime mortgages are typically of
smaller value and made to borrowers with some blemish on their credit history.
• Borrowers in negative equity are twice as Alt-A, or “near-prime,” mortgages are typically larger value loans made to
likely as those in positive equity to be borrowers who, for a variety of reasons, may not choose to provide the
seriously delinquent, or in default, on their documentation of income or assets typically required to obtain a prime
first-lien mortgage. 2
As reported, for example, at (<
2007/11/04/news/companies/citigroup_prince/index.htm>) and BBC News
(<>). See also Bernanke

Andrew F. Haughwout is an assistant vice president and Ebiere Okah The views expressed are those of the authors and do not necessarily reflect the
an assistant economist at the Federal Reserve Bank of New York. position of the Federal Reserve Bank of New York or the Federal Reserve
Correspondence: <> System.

FRBNY Economic Policy Review / Forthcoming 1
Chart 1 Chart 2
Nonprime Loan Originations by Year Mean FICO Score by Vintage
Percentage of sample Score
30 680

25 660

20 640

15 620

10 600

5 580

0 560
Pre- 2000 2001 2002 2003 2004 2005 2006 2007 Pre- 2000 2001 2002 2003 2004 2005 2006 2007
2000 2000

Source: FirstAmerican CoreLogic, LoanPerformance data. Source: FirstAmerican CoreLogic, LoanPerformance data.

The mortgage industry’s standard view of default risk has the second quarter of 2005, the Office of Federal Housing
historically focused on four underwriting characteristics at Enterprise Oversight’s (OFHEO) national house price index
mortgage origination: borrower credit rating, loan-to-value began to slow, and ultimately declined. By the fourth quarter
(LTV) ratio, debt-to-income (DTI) ratio, and the extent of of 2008, the annual growth rate of the index was -4.5 percent
third-party income and asset verification. However, changes in (Chart 3), and the reversal was even sharper in certain areas
these characteristics alone seemed insufficient to explain the of the country.
severe and rapid erosion in the status of nonprime loans Observers in the popular media and in the research
(Demyanyk and van Hemert 2008; Haughwout, Peach, and community quickly pointed to the confluence of house price
Tracy 2008). While some underwriting criteria deteriorated as declines and mortgage defaults as more than coincidence
the nonprime market share expanded, others changed little or
even improved. For example, mean credit bureau (FICO)
scores of nonprime borrowers increased steadily after 2001
Measures of housing units with negative
(Chart 2), largely as a result of a shift in the composition of the
nonprime pool to alt-A loans. equity . . . have become a necessary
In light of these mixed developments, some analysts turned component in crafting policies to address
to the economy to explain the poor mortgage performance.
However, because economic growth between 2005 and 2007 the current foreclosure crisis.
was fairly steady—real GDP expanded 3.1, 2.9, and 2.2 percent,
respectively, in those three years while the unemployment rate
fell below 5 percent—sharp income declines seemed to be an (Gerardi, Shapiro, and Willen 2007; Haughwout, Peach, and
unlikely source of the widespread increases in nonprime Tracy 2008; Demyanyk and van Hemert 2008). Indeed, a large
delinquencies and foreclosures. body of research on mortgage defaults indicates that declines in
To be sure, aggregate statistics may mask changes in house prices—or, more precisely, reductions in borrower
individual circumstances. When a borrower experiences a equity—are fundamental contributors to default (see, for
deterioration in personal finances, the borrower’s amount of example, Vandell [1995] and Elul [2006]); evidence from the
home equity largely influences his or her course of action. One current downturn, although limited, confirms this hypothesis
underlying economic factor that did deteriorate concurrently (see, for example, Foote, Gerardi, and Willen [2008]).4
with mortgage performance was house price appreciation. For this reason, measures of housing units with negative
After peaking at an annual growth rate of 12.1 percent in equity—that is, homes whose mortgage balance exceeds the
3 value of the collateral housing unit—have become a necessary
These figures include loans that are at least ninety days delinquent, are in
foreclosure, or are Real-Estate-Owned (REO)—that is, ownership of the component in crafting policies to address the current
collateral has been transferred to the lender. foreclosure crisis. In this article, we estimate negative equity in

2 Below the Line
Chart 3 2. Data and Methods
Home Price Indexes
Comparison of OFHEO and S&P/Case-Shiller
We combine information from several sources to obtain our
Year-over-year estimates of negative equity nonprime mortgages in the United
percentage change
States. Our primary source of information on individual loans
is FirstAmerican CoreLogic’s LoanPerformance data set. As
of February 2009, the data set provided monthly loan-level
information on approximately 4.8 million active, securitized
subprime and alt-A loans with total balances of more than
$1 trillion. While LoanPerformance captures more than
S&P/Case-Shiller 90 percent of securitized nonprime loans after 1999 and nearly
-10 100 percent of the crucial 2003-05 vintages, it excludes all loans
held in bank portfolios (Mayer and Pence 2008). Pennington-
-20 Cross (2002) argues that securitized subprime mortgages differ
2000 01 02 03 04 05 06 07 08
systematically from those retained in portfolios; loans held in
Sources: Office of Federal Housing Enterprise Oversight (OFHEO);
Standard and Poor’s.

We rely on two sources of house price
growth to estimate negative equity: the
the U.S. nonprime mortgage market for 2008-09, and beyond,
with the goal of describing the sources of the problem and the widely used [Office of Federal Housing
characteristics of borrowers in a negative equity position. Our Enterprise Oversight] house price index and
results suggest that the prevalence and magnitude of negative
the S&P/Case-Shiller home price index.
equity are closely associated with the time and place of mortgage
origination and with the existence of subordinate liens against
the property. In addition, borrowers in negative equity are
bank portfolios may look substantially different. Because our
much more likely to be seriously delinquent, or in default, on
data are limited to securitized loans, any inferences should be
their first-lien mortgage than borrowers in positive equity.
limited to this set of loans.
Our study is organized as follows. Section 2 describes our
The LoanPerformance data set offers a rich source of
sample of mortgage data and our methods as well as discusses
information on the characteristics of securitized nonprime
how changes in mortgage underwriting and house price
loans, such as the date of loan origination, the Zip code in
dynamics can affect borrower equity. In Section 3, we present
which the collateral property is located, details of the mortgage
estimates of negative equity mortgages as well as examine the
contract, and underwriting information. Also included are
static relationship between negative equity and mortgage
monthly updates of dynamic information such as current
default. In Section 4, we discuss our results and use
interest rates, mortgage balances, and the borrower’s payment
information from other studies and from housing price futures
contracts to examine the relationship between borrower equity
We analyze a 1 percent random sample of the first-lien
and house price dynamics. Section 5 summarizes our key
subprime and alt-A loans reported in the data set as of
December 1, 2008.5 Our data include more than 49,000 active,
or not yet repaid, loans. We combine the loan-level data with
aggregate data on house price dynamics for each metropolitan
statistical area (MSA) in the sample. Because our data set is a
sample, it is subject to sampling variation, but for ease of
We define equity as the book equity of a loan, where the mortgage balance is exposition we report only point estimates, not standard errors.
subtracted from the home’s value. This definition is not to be confused with the
difference between mortgage value and home value. Because the market value Because observations in the LoanPerformance data set are loans coded to
of the mortgage will neither be larger than its balance (since the loan is Zip code, we choose our data set from the universe of first-lien loans only. This
discounted for risk) nor greater than the underlying asset of the home, it is approach avoids the possibility of double counting subordinate-lien loans
possible to have both positive equity and negative book equity. While market on the same property. While the LoanPerformance data set also includes
equity is an important concept, we focus on the difference between the balance information on nonprime subordinate liens, it is impossible to match these
on the mortgage and the value of the house; thus, we refer to book equity loans to the first liens. Nonetheless, as we discuss, we do observe the balance
simply as “equity.” on subordinate liens at origination of the first lien.

FRBNY Economic Policy Review / Forthcoming 3
We rely on two sources of house price growth to estimate Chart 4
negative equity: the widely used OFHEO house price index and Combined Loan-to-Value Ratios by Vintage
the S&P/Case-Shiller home price index.6 Although both
indexes are based on repeat transactions on the same property 140
over time, they differ in important ways. OFHEO, which
provides separate indexes for 381 MSAs, enables us to estimate 120

house price changes for the great majority of properties in our
loan-level data set. However, the OFHEO index is based on the
sale price or appraisal value of homes with prime, conforming 80
mortgages, that is, those securitized by government-sponsored
enterprises.7 Because the properties we study are by definition 60

Pre- 2000 2001 2002 2003 2004 2005 2006 2007
An interesting feature revealed by the data
Sources: FirstAmerican CoreLogic, LoanPerformance data; authors’
is that while first-lien loans remained at calculations.
relatively stable [loan-to-value ratios] Notes: For each year, the shaded box indicates the middle 50 percent of
the data. Thus, the top of each box represents the 75th percentile value
throughout the 2000-08 period, and the bottom the 25th. The line intersecting each box shows the median
value. The thin lines extending from the boxes represent the upper and
subordinate liens became more common lower adjacent ranges, which extend at most 1.5 times the interquartile
range in both directions.
and rose in value as a percentage
of house value.
are influenced importantly by the treatment of lower priced
houses. Using the S&P/Case-Shiller price parameters as a guide,
financed with a nonprime mortgage, OFHEO’s focus on these we determined that its middle- and high-tier indexes best
government-sponsored mortgages introduces the possibility of estimate house prices for subprime and alt-A loans,
measurement error in our estimate of house price appreciation, respectively.8
with the sign and magnitude of the error depending on how To estimate equity in properties, we perform a series of
appreciation varies across market segments. basic calculations. First, we use data from LoanPerformance
The S&P/Case-Shiller index addresses this problem in two to calculate the borrower’s net equity in the property at the
ways. First, it covers all sales, not just those in the prime market origination of each first-lien loan. This measure captures
segment. Second, it provides supplementary indexes for three both the balance of the first lien as well as the balances of all
tiers in each of the markets it covers. The tiers divide each subordinate liens, if any exist. An interesting feature revealed
market into thirds—low, middle, and high—based on area by the data is that while first-lien loans remained at relatively
house prices as of December 2008. For example, Los Angeles stable LTVs throughout the 2000-08 period, subordinate
MSA properties with prices under $309,184 are in the low tier, liens became more common and rose in value as a percentage
prices between $309,184 and $470,182 make up the middle tier, of house value. Chart 4 plots combined (all liens) LTV ratios
and prices above $470,182 are considered high tier. Inspection by vintage. It shows that until 2003, LTVs were fairly steady,
of the house price dynamics in these tiers indicates that they with a median of 80; after 2003, however, the median LTV
indeed differ from the composite measure, suggesting that, began climbing. By 2006, the median origination LTV of
for our purposes, measurement error using the OFHEO index nonprime loans was 89.3, and fully 25 percent of the loans
is likely nontrivial. This suspicion is confirmed by Leventis had an LTV of at least 100. That is, a quarter of borrowers
(2008), who finds that differences between the two indexes who took nonprime mortgages in 2006 had no equity at
For more details, see <> and We calculate origination equity, which is house value of
Indices_Factsheet.pdf>. In July 2008, OFHEO became the Federal Housing
the first-lien loan ( HV0 ) minus total balances on all L liens
Finance Agency, but we continue to refer to the index as the OFHEO index. ∑ ΣL M l at origination. Equity at time t is then simply initial
l =1 0
Concerns have been raised that appraisals during the “boom” years of
nonprime lending were biased upward. OFHEO does publish a national In each S&P/Case-Shiller MSA, the mean price of a home collateralizing a
“purchase-only” index that incorporates data only from actual sales, but subprime mortgage was in the middle tier, while alt-A home prices were in
this index is not available for individual MSAs. the high tier.

4 Below the Line
equity plus any house price appreciation, minus any increase in Table 1
mortgage balances after origination: OFHEO-Based Negative Equity Estimates
December 1, 2008
Et = ∑
HV0 – Σl = 1 M 0
L l

+ Δ HVt – Σ l = 1 Δ M 0 .
L l

Negative Equity
Net equity can change in three distinct ways: Number of Loans (Percent)

First lien 10,144 21
• principal amount on the first-lien mortgage changes
1 All liens 13,766 29
Δ M t ≠ 0 (typically, mortgage balances will decline Total loans 47,876 100
over time, meaning that Δ M t < 0 ),
Source: FirstAmerican CoreLogic, LoanPerformance data.
• principal amount(s) on subordinate liens changes
∑ΣL Δ M l ≠ 0 ,
l=2 0
Note: House value changes are estimated using the Office of Federal
Housing Enterprise Oversight (OFHEO) indexes for individual
• house value changes ΔHVt ≠ 0 . metropolitan statistical areas.

We have direct, micro-level evidence on only the first
component, because LoanPerformance tracks monthly
balances on each first-lien loan we observe. We use each MSA’s sluggish growth: the city’s peak growth year was 2003, when
OFHEO and S&P/Case-Shiller indexes to estimate changes in prices rose just 5.4 percent.9
house values since loan origination. For balances on The combination of a falling housing market and a large
subordinate liens, we assume that the borrower makes regular number of homeowners holding little or no equity at mortgage
interest payments, but that principal amounts remain origination created a perfect storm for generating negative
unchanged. Note that this is somewhat of a “middle-ground” equity. Note that for a mortgage with an apparently safe
assumption: borrowers may either make progress reducing origination LTV ratio of around 80, a 20 percent decline in

the balances on subordinate liens ( Σ l = 2 Δ M t < 0) or they
L l
house value—not uncommon in many metro areas in 2007—
may layer additional liens on top of those we observe could potentially erase essentially all of the homeowner’s

( Σ l = 2 Δ M t > 0).
L l equity. One should not be surprised, therefore, to find that the

The combination of a falling housing
3. Negative Equity among market and a large number of
Nonprime Borrowers
homeowners holding little or no equity
Two developments important for understanding homeowner at mortgage origination created a perfect
equity occurred after 2002. First, full loan-to-value ratios rose
sharply as junior liens became more common and larger. This
storm for generating negative equity.
change is present throughout the post-2002 period, but it is
especially significant in 2006—when more than 25 percent of
nonprime originations had initial LTV ratios of 100 or more incidence of negative equity grew substantially in 2006 and
(Chart 4). 2007. What we now consider is exactly how large and how
Second, starting in 2005, the house price environment, common nonprime negative equity mortgages have become,
whether measured by the OFHEO or the S&P/Case-Shiller where they are concentrated, and their consequences for
index, became much less favorable for building borrower borrower behavior.
Our December 1, 2008, OFHEO-based estimates indicate
equity (Chart 3). This reversal was especially sharp in some
that 21 percent of borrowers were in negative equity on
areas that had experienced the highest growth prior to 2005.
their first lien while 29 percent were in negative equity when
The Las Vegas MSA, for instance, saw its house price growth
junior liens were included (Table 1). By comparison, the
rate, measured by the S&P/Case-Shiller index, decline from
percentage of nonprime borrowers facing negative equity was
more than 42 percent in 2003 to -15 percent in 2007. Parts of
3 percent and 13 percent in April 2008, calculated using first
the Midwest experienced a similar phenomenon, but it resulted
and combined liens, respectively. At that time, borrowers
from a different set of dynamics. In Cleveland, for example,
the S&P/Case-Shiller index declined just 1.7 percent in 2007. 9
Growth rates in this discussion are measured as December-over-December
However, the decline followed a long period of relatively percentage growth.

FRBNY Economic Policy Review / Forthcoming 5
Table 2 Chart 5
Comparison of S&P/Case-Shiller and OFHEO Negative Equity by Origination Year
December 1, 2008 Percent
Number Negative Equity
of Loans (Percent) 50
S&P/Case-Shiller negative equity estimates 40
First lien 7,150 34
All liens 9,989 47 30
Total loans 21,164 100 20
b 10
OFHEO negative equity estimates
First lien 4,945 23 0
All liens 7,367 35 Pre- 2000 2001 2002 2003 2004 2005 2006 2007
Total loans 21,164 100 2000

Source: FirstAmerican CoreLogic, LoanPerformance data.
Source: FirstAmerican CoreLogic, LoanPerformance data.
House value changes are estimated using the S&P/Case-Shiller high- and
medium-tier indexes for individual metropolitan statistical areas.
House value changes are estimated using the Office of Federal Housing
Enterprise Oversight (OFHEO) indexes for individual metropolitan
statistical areas.
restricted set of cities; thus, we focus on the seventeen cities
for which we have S&P/Case-Shiller tiered information.
Nonetheless, we also report OFHEO results—especially when
analyzing the entire United States—to provide a broader view
with junior liens were more than four times as likely to be of nonprime mortgages.
in negative equity, an incidence that demonstrates the Recall that the time of loan origination is important for
importance of second liens in determining negative equity. determining negative equity because the two determinants of
However, home prices have dropped markedly since then, negative equity—the value of the home and the ratio of the
placing many more borrowers in negative equity—even those
who had made a sizable down-payment or had just a single
lien on their property. The importance of vintage suggests that
Limiting our analysis to the seventeen cities covered by one would expect areas that experienced
the S&P/Case-Shiller tiered indexes paints a bleaker picture
housing booms during 2004-06,
(Table 2). Using this measure of house price changes, we
estimate that 47 percent of housing units with nonprime especially locations where borrowers took
mortgages—nearly 1 million households in these seventeen loans with small down-payments, to have
cities alone—are in a negative equity position. However,
application of the OFHEO index to this restricted set of cities
the highest prevalence of negative equity.
produces a lower estimate of 35 percent, or 736,700 mortgages, Our data support this hypothesis.
in negative equity.10
This disparity highlights the difference in market segments
tracked by both indexes. While neither measure exactly loan to the initial value of the home—both correlate with
captures the nonprime securitized market, the S&P/Case- vintage. Increases in full LTV ratios at origination, combined
Shiller index includes properties covered by these loans, while with the sharp reversal in home prices in 2006, suggest that
the OFHEO’s reliance on conforming mortgages prevents it borrowers who took mortgages later in the period would be
from doing so. However, OFHEO’s national coverage offers more likely to find themselves with no equity in their property.
an enormous advantage when estimating the prevalence of As Chart 5 shows, very small shares of nonprime mortgages
negative equity in aggregate. We have opted to concentrate on that originated before 2003 were in negative equity by
what we consider the more accurate data set available for a December 2008, but negative equity rates were sharply higher
in subsequent vintages. All told, we estimate that the difference
These figures are population estimates based on the sample information between house values and nonprime balances in these cities
reported in Table 2. totals more than $58 billion (Table 3).

6 Below the Line
Table 3
Negative Equity by Metropolitan Statistical Area

Negative Equity Average Difference between Mortgage Balance Total Amount in Negative Equity
Area (Percent) and House Value (Dollars) (Thousands of Dollars)

Atlanta 45 18,016 983,660
Boston 21 17,156 202,440
Chicago 35 18,201 964,670
Cleveland 32 9,865 114,440
Denver 33 12,607 267,280
Las Vegas 89 83,654 7,871,870
Los Angeles 52 80,484 13,593,690
Miami 69 68,357 10,417,590
Minneapolis 61 32,839 1,155,940
New York 13 22,119 822,840
Phoenix 80 73,314 9,024,990
Portland 24 18,676 190,500
San Diego 61 84,371 4,496,990
San Francisco 39 65,986 2,830,800
Seattle 21 17,125 236,330
Tampa 60 37,110 1,888,910
Washington, D.C. 47 52,113 3,397,760
Seventeen-area composite 47 58,496 58,460,690

Source: FirstAmerican CoreLogic, LoanPerformance data.

Notes: House value changes are estimated using the S&P/Case-Shiller high- and medium-tier indexes for individual metropolitan statistical areas.
Mortgage balances on junior and senior liens are combined. The last column represents the population counts.

The importance of vintage suggests that one would expect average initial LTVs are significantly higher on negative equity
areas that experienced housing booms during 2004-06, loans (Table 4; Table 5 provides the same information for
especially locations where borrowers took loans with small states, using the OFHEO index). Debt-to-income ratios are
down-payments, to have the highest prevalence of negative typically higher among negative equity borrowers as well.
equity. Our data support this hypothesis. Almost a quarter of Interestingly, credit bureau scores are generally higher among
the negative equity properties in the seventeen S&P/Case- the negative equity borrowers.11 The fact that “borrower
Shiller cities are in one of the three California MSAs, with more quality” at origination is roughly the same for positive and
than 15 percent in Los Angeles alone (Table 3). In addition, negative equity loans is a relevant consideration when
negative equity is much larger in the California (and to a lesser interpreting default behavior.
extent Florida) cities than elsewhere in the country. The To gain an understanding of mortgage repayments, it is
California cities saw relatively large declines in housing prices crucial to analyze the relationship between equity status and
and had larger than average mortgages—factors that led to default behavior. Recent research on defaults has shown the
a greater prevalence and intensity of negative equity. Thus, importance of house price appreciation in influencing
borrowers who received high LTV loans in 2006-07 in areas nonprime mortgage outcomes (Demyanyk and van Hemert
that experienced sharp house price reversals are very likely to 2008; Gerardi, Shapiro, and Willen 2007). Demyanyk and
find themselves in a negative equity position. van Hemert (2008) find that borrowers whose houses have
Table 5 reports these results using the OFHEO index of the broader set of
states. While the estimated shares in negative equity in the broader sample are
consistently lower than the shares in Table 4’s more narrow sample of
3.1 Borrower Characteristics and Behavior seventeen MSAs, they demonstrate similar spatial patterns—with the bulk of
negative equity properties concentrated in boom states, especially California.
An examination of borrower and loan characteristics by equity In addition, the broader sample’s concentration of negative equity loans
among borrowers with relatively high credit scores, high DTI ratios, and high
status shows that, not surprisingly, the most striking difference
combined LTV ratios at origination is similar to the more narrow sample’s
between positive and negative equity loans is the combined concentration. Neither sample demonstrates a clear relationship between
(senior plus junior) LTV ratio at origination; in each MSA, equity and documentation level.

FRBNY Economic Policy Review / Forthcoming 7
Table 4
Underwriting Characteristics by Equity Status and Metropolitan Statistical Area

Equity Status Fully Documented
Area (Percent) Debt-to-Income Ratio FICO Score Loan-to-Value Ratio (Percent)
Seventeen-area composite
Positive equity 53 38 673 73 43
Negative equity 47 40 678 91 36
Positive equity 55 35 673 80 56
Negative equity 45 40 668 98 61
Positive equity 79 39 662 72 42
Negative equity 21 42 678 98 42
Positive equity 65 39 641 80 53
Negative equity 35 42 667 97 40
Positive equity 68 37 636 82 62
Negative equity 32 41 646 97 78
Positive equity 67 38 675 82 57
Negative equity 33 42 671 99 61
Las Vegas
Positive equity 11 34 689 65 39
Negative equity 89 39 683 88 33
Los Angeles
Positive equity 48 38 692 63 35
Negative equity 52 41 690 89 22
Positive equity 31 38 654 67 42
Negative equity 69 39 667 88 33
Positive equity 39 36 673 76 52
Negative equity 61 41 668 95 54
New York
Positive equity 87 40 663 75 38
Negative equity 13 42 686 98 22
Positive equity 20 35 693 70 48
Negative equity 80 39 673 87 41
Positive equity 76 37 685 79 47
Negative equity 24 41 691 98 44
San Diego
Positive equity 39 36 703 60 33
Negative equity 61 40 699 88 26
San Francisco
Positive equity 61 36 716 65 32
Negative equity 39 40 693 91 24
Positive equity 79 39 678 81 50
Negative equity 21 39 694 97 44
Positive equity 40 35 659 73 49
Negative equity 60 39 666 90 40
Washington D.C.
Positive equity 53 39 675 71 44
Negative equity 47 41 677 94 38

Source: FirstAmerican CoreLogic, LoanPerformance data.
Notes: House value changes are estimated using the S&P/Case-Shiller high- and medium-tier indexes for individual metropolitan statistical areas.
Mortgage balances on junior and senior liens are combined. Details may not sum to totals because of rounding.

8 Below the Line
Table 5
Underwriting Characteristics by Equity Status and State

Equity Status Fully Documented
State (Percent) Debt-to-Income Ratio FICO Score Loan-to-Value Ratio (Percent)

Non-boom and non-bust states

Forty-three-state composite
Positive equity 91 38 655 83 55
Negative equity 9 42 672 98 44

Boom states

Positive equity 57 37 674 75 46
Negative equity 43 40 676 93 40

Positive equity 43 37 695 64 37
Negative equity 57 40 685 88 28

Positive equity 51 38 657 75 46
Negative equity 49 39 666 91 35

Positive equity 20 37 687 69 39
Negative equity 80 39 683 89 34

Bust states

Positive equity 98 37 640 87 70
Negative equity 2 40 623 98 79

Positive equity 47 37 637 77 65
Negative equity 53 40 646 93 65

Positive equity 89 38 638 86 67
Negative equity 11 41 645 99 76

Source: FirstAmerican CoreLogic, LoanPerformance data.

Notes: House value changes are estimated using the Office of Federal Housing Enterprise Oversight indexes for individual states. Mortgage balances
on junior and senior liens are combined. Details may not sum to totals because of rounding.

appreciated less, or depreciated more, tend to default more, all Haughwout, Peach, and Tracy (2008) study the probability
else equal. In much of this work, borrower default is treated as that a borrower will fall at least ninety days behind on
a continuous function of house value; in contrast, we analyze a scheduled payments within the first year of a nonprime
sharp break at zero equity. The idea that borrower behavior mortgage. The authors report very large ceteris paribus jumps
might change markedly as properties pass into negative equity in this probability as LTV ratios rise above 100, particularly
is supported by both theory and empirical evidence. Theory among borrowers who are not owner-occupants. They find
predicts that borrowers with positive equity will rarely default, that negative equity adds approximately 7 percentage points to
but those with little or no equity will sometimes determine that default probability for owner-occupants and between 15 and
default is the best option. When equity declines by a particular 20 percentage points for investors, compared with similar
amount—that is, if house values fall enough after loan owners with slightly positive equity in their properties (that is,
origination—borrowers reach a critical value where they are those with LTV ratios between 95 and 100).
certain to default (Vandell 1995).

FRBNY Economic Policy Review / Forthcoming 9
Table 6
Loan Status by Borrower Equity

Days Delinquent
Thirty Sixty Ninety or More Foreclosure Real-Estate-Owned

First lien
Positive equity 8 4 8 8 4
Negative equity 9 6 12 17 9
All liens
Positive equity 7 4 7 7 3
Negative equity 8 5 11 16 9

Source: FirstAmerican CoreLogic, LoanPerformance data.

Note: House value changes are estimated using the S&P/Case-Shiller high- and medium-tier indexes for individual metropolitan statistical areas.

In related work, Foote, Gerardi, and Willen (2008) study properties in foreclosure or REO are in a positive equity
ownership experiences of prime and nonprime borrowers in position (Table 6). This conclusion may appear to contradict
Massachusetts beginning in the late 1980s. They produce two the argument that negative equity is a necessary condition for
findings of relevance for our analysis: subprime borrowers are default. The high number of positive equity properties in
much more likely to default in general than those holding foreclosure may reflect mismeasurement of housing equity or
conforming mortgages, and borrowers with negative equity are
more likely to default after five years (and are less likely to sell
their properties) than those with positive equity. Our foreclosure rates . . . reflect not only
As expected, we find that the share of positive equity loans
the prevalence of entering foreclosure,
ninety or more days delinquent is a little more than half the rate
for loans with negative equity (Table 6). However, borrowers which itself is influenced by both borrower
with negative equity are just as likely to be thirty days and lender behavior, but also the time
delinquent—but twice as likely to be in foreclosure and three
that a property in default spends in
We find that the share of positive equity
loans ninety or more days delinquent is a the presence of transaction costs that make default a better
little more than half the rate for loans with option than continuing to make payments on the loan.12
We find that our estimates of borrower equity are lower for
negative equity. those properties that are delinquent ninety days or more, in
foreclosure, or in REO (Table 7). When prepayment penalties
and the possibility of mismeasurement of house values are
times as likely to have passed through the foreclosure process considered, these borrowers may perceive themselves to be in
and be in REO by the lender. Thus, a fall in home prices may negative equity on their mortgages, a factor that helps explain
not precipitate initial delinquency, but it may encourage their behavior.
default by a homeowner who is already having difficulty Although these results are qualitatively consistent with those
making payments. This outcome is consistent with results from of Foote, Gerardi, and Willen (2008) and Haughwout, Peach,
a model in which some borrowers experience shocks to their and Tracy (2008), a direct comparison is difficult. In particular,
income and fall a month or two behind on their mortgages, because our mortgage data set consists entirely of nonprime
then decide whether to prepay (sell or refinance) or default. loans, we observe the effect of negative equity on that subsample
When their equity is below zero, the tendency to default is
relatively strong. Recall that we describe negative book equity. It is possible that many of the
loans that we measure as having positive equity have prepayment fees or other
While only 10 percent of positive equity homes are in fore- features that put the default option “in the money.” It is also possible that we
closure or REO on all liens, we estimate that 31 percent of underestimate house price declines for some of these loans.

10 Below the Line
Table 7
Loan Status among Positive Equity Borrowers

Days Delinquent

Current Thirty Sixty Ninety or More Foreclosure Real-Estate-Owned

Average difference between mortgage balance
and house value (dollars) 137,610 86,294 71,683 76,291 59,898 42,954
Average difference as a percentage of house value 28 22 20 17 15 13

Source: FirstAmerican CoreLogic, LoanPerformance data.

Notes: House value changes are estimated using the S&P/Case-Shiller high- and medium-tier indexes for individual metropolitan statistical areas.
Mortgage balances on junior and senior liens are combined.

of the Foote, Gerardi, and Willen population. In addition, we contracts expiring in November 2009 had a combined negative
observe a single cross-section of properties in foreclosure at a equity rate of 45 percent, very near the average rate of 47 per-
point in time, as opposed to the Foote, Gerardi, and Willen cent for the seventeen cities tracked by the S&P/Case-Shiller
approach of observing the timing of entry into default and the index. We estimate that the trajectories implied by the futures
Haughwout, Peach, and Tracy analysis of delinquency within contracts would increase the negative equity rate to 61 percent
the first year of origination. Our foreclosure rates thus reflect by late 2009 and add 135,500 borrowers to the ranks of those
not only the prevalence of entering foreclosure, which itself is whose homes are worth less than their mortgage balances in
influenced by both borrower and lender behavior, but also the
time that a property in default spends in foreclosure.
Negative equity’s important effect on
borrower default underscores the value
of understanding the potential future path
4. Looking Ahead
of negative equity.
Negative equity’s important effect on borrower default
underscores the value of understanding the potential future
path of negative equity. Accordingly, we look at two possible these five cities. The contracts forecast the percentage of
relationships between negative equity and nonprime borrowers with negative equity in their homes to decrease
borrowing going forward. by the end of 2010 (Chart 6). These calculations are derived
We begin by using the S&P/Case-Shiller home price index. using the percentage changes in home prices predicted for the
The index has the advantage of covering a large number of S&P/Case-Shiller composite index and applying the changes to
homes in the small number of markets for which it is available. its high- and medium-tier indexes, assuming that borrowers
Another advantage is that futures contracts on the index trade fall no further behind on their mortgages.
on the Chicago Mercantile Exchange.13 As a result, the path of A second potential relationship between negative equity
the indexes in individual MSAs can be predicted. The futures and house prices is somewhat more general. Chart 7 presents
contracts currently provide estimates of house price the number of borrowers in various equity categories as of
appreciation in several cities for various months through December 2008, where equity is expressed as a percentage of
November 2012.14 house value. Here we use the OFHEO index, which offers the
Our examination of futures contracts on S&P/Case-Shiller broadest coverage. Assuming that no changes in mortgage
indexes points to further deterioration in home prices in the balances occur, one can estimate the number of new negative
cities covered. As of December 2008, the five cities with equity borrowers by moving the chart’s “zero line.”15 For
example, the effect of a 10 percent decline in house prices
See <> for more information. can be estimated by moving this line two bars to the right.
The cities are Boston, Denver, Las Vegas, Los Angeles, New York, San Diego,
According to this scenario, approximately 1.5 million (719,600
San Francisco, and Washington, D.C.; futures prices for Miami are available
only through November 2010. While these markets are relatively thinly traded, plus 770,000) new nonprime borrowers would see their house
activity picks up following release of the S&P/Case-Shiller home price index.
We thus use the futures prices for contracts that had “open interest” on March 31, 15
Alternatively, if one believes that the OFHEO index is 10 percent overvalued,
2009: the release date for the January 2009 S&P/Case-Shiller index. one might conduct a similar exercise to estimate current negative equity rates.

FRBNY Economic Policy Review / Forthcoming 11
Chart 6 Chart 7
Potential Path of Negative Equity Ratio of Equity to House Prices
As of December 2008
100 Frequency (in thousands) Density (percent of sample)
December 1, 2008
90 880 18.4
November 2009
80 770 16.1
November 2010
660 13.8
50 550 11.5
40 440 9.2
30 330 6.9
220 4.6
0 110 2.3
s s i rk co .
ega ele iam Yo cis D.C 0 0
sV ng M w n n,
La sA Ne Fra gto -120 -100 -80 -60 -40 -20 0 20 40 60 80 100
Lo Sa
Borrower equity as a percentage of house value

Sources: FirstAmerican CoreLogic, LoanPerformance data; Sources: FirstAmerican CoreLogic, LoanPerformance data;
Chicago Mercantile Exchange. Office of Federal Housing Enterprise Oversight.

value fall below their current mortgage balance. This path of they are disproportionately concentrated in housing markets
house prices would raise our OFHEO-based estimate of the that experienced especially large swings in house price
negative equity share to roughly 45 percent. Conversely, a appreciation, particularly in California. We estimate that three
turnaround in the housing market that resulted in a 10 percent California metropolitan areas account for more than a quarter
increase in house values would lift 729,200 borrowers into of the negative equity mortgages in our sample. Moreover,
positive equity, reducing the rate to just 14 percent.16 because of the higher balances on these mortgages, the loans
These arguably plausible changes in the value of the OFHEO account for nearly half of the overall difference between house
index have very large effects on the incidence of negative equity values and mortgage balances.
among nonprime borrowers because, as Chart 7 shows, many Going forward, further house price declines will lead to
hundreds of thousands of borrowers are very near zero equity. continued increases in the number of nonprime mortgages in
Relatively small changes in house prices from this point negative equity. If house prices fall an additional 10 percent
forward can therefore have large influences on both the from their December 2008 levels, we estimate that approxi-
incidence of negative equity and, by extension, the risk of mately 1.5 million new mortgages nationwide will carry
default by nonprime borrowers. balances that exceed the value of the collateral homes. The
aggregate difference between these balances and house values
could approach $135 billion.
Although negative equity is a necessary condition for default,
5. Conclusion it does not always lead to default. As other studies, including
ours, have shown, borrowers do not automatically default when
Recent declines in house values have put hundreds of their house value drops below their mortgage balance.
thousands of nonprime borrowers in a negative equity Nonetheless, research has demonstrated that negative equity
position, that is, with a house value below the property’s borrowers are far less likely to prepay their mortgages and
mortgage balance. Our study finds that nonprime borrowers in are more likely to become seriously delinquent and thus
negative equity share several characteristics: for example, they default. We find that among nonprime borrowers, the default
took out loans near the peak of the housing market and their probability of an outstanding negative equity mortgage is two to
loans had high LTV ratios usually achieved with subordinate three times as high as that of a positive equity borrower. In this
liens in addition to the first lien. We also find that while context, the future direction of house prices will be a critical
negative equity loans exist in most U.S. metropolitan areas, determinant of the payment behavior of nonprime borrowers.
Note that these estimates are imprecise, as they do not account for changes
in mortgage balances over time.

12 Below the Line

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The views expressed are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York
or the Federal Reserve System. The Federal Reserve Bank of New York provides no warranty, express or implied, as to the
accuracy, timeliness, completeness, merchantability, or fitness for any particular purpose of any information contained in
documents produced and provided by the Federal Reserve Bank of New York in any form or manner whatsoever.

FRBNY Economic Policy Review / Forthcoming 13